Attorney laments new PACA precedent, while others say case breaks no new ground

by Tim Linden | May 21, 2009

An attorney familiar with PACA law believes that a recent decision by a New York court allows preferential payments of PACA Trust creditors and should cause sellers to file suit early and often when the potential for a bad debt arises.

However, several other attorneys, who are also experts in PACA law, disagree with the significance of the recent decision and believe there has been no change in case law, and buyers and sellers need to do nothing differently.

Michael Keaton of Keaton & Associates in Palatine, IL, believes that the just- released decision in the H.C. Schmieding Produce Co. v. Alfa Quality Produce case by a New York District Court grants preferential treatment to those who file claims early. He said that in essence, the court allows a PACA Trust creditor to come in and deplete the funds of a company, forcing it into insolvency and leaving no funds available to be distributed to other creditors.

Mr. Keaton, who was on the losing end of this ruling, said that the decision is the polar opposite of how a District of Columbia Federal Court ruled seven years ago in the case of Fresh Kist Produce v. Choi Corporation. In that case, Mr. Keaton said that he successfully argued that PACA Trust law requires all trust creditors to be dealt with equally in an insolvency situation.

In the Fresh Kist case, the court did require some payments that were made to a shipper prior to the insolvency to be brought back into the court and be distributed equally to all PACA Trust creditors on a pro rata basis.

The court ruled that the salient fact in that case was that the shipper knew that Choi was insolvent when it accepted payment for a debt prior to the insolvency. Hence the payment was "pulled back" as part of the Trust funds. Mr. Keaton argued that the same circumstances occurred in the Schmieding case. He said that several Trust creditors received payments even though they knew that Alfa Produce was insolvent. He argued that those monies should be pulled back and distributed equally to all PACA Trust creditors that came into the case after insolvency was formally established.

Mr. Keaton said the court found that since the PACA Trust law did not address this situation, it relied on common law to allow the preferential payments. He said that this is an erosion of PACA Trust law, and he believes that it is precedent setting.

The Illinois attorney claims that the "net result of the Schmieding court's ruling is that every credit manager or owner of a produce company needs to understand the rules have changed. Gone are the days of share and share alike. ... Now you know every PACA creditor needs to jump on the slow- paying buyer early or risk knowing there will be nothing left in the Trust when they get around to enforcing their PACA Trust rights for payment."

A number of other attorneys disagreed with both Mr. Keaton's characterization of the importance of the decision as well as his restating of the facts in the case. They also supported PACA Trust law as well as case history, which does not "pull back" Trust-qualified payments made to creditors prior to an insolvency.

Lou Diess of McCarron & Diess in Washington, DC, who is involved in the Schmieding case, did not want to comment on the specifics of that case because it might be appealed. However, he did say that the Fresh Kist decision was out of the ordinary and that he disagreed with that decision. In fact, he said he represented Trust clients in that insolvency case who did not have their debt payments "pulled back" because they had no knowledge of the insolvency when they were paid. He added that those same general facts were present in the Schmieding case (which combined many different suits under that name).

Mr. Diess said that if a payment is made to a Trust creditor when a debtor firm is an ongoing operation, then there should be no question that the money is the creditor's to keep. He said it would be an impossible and costly task as well as an undue burden on a seller to ascertain the specific financial situation of the debtor each time he tried to collect a debt.

"That would be unworkable," he said. "Do we really want a produce company having to do that each time? That would not be good for the industry." Mark Amendola of Martyn & Associates in Cleveland also doubted the precedent-setting nature of the Schmieding decision. "It is insignificant," he said.

Mr. Amendola said that the Fresh Kist decision was an "extreme minority decision" not supported by any other PACA case in history. He said that in virtually every other PACA Trust case, a distinction is made with regard to payments prior to insolvency and those payments made once a company is insolvent. Payments made prior are the property of the creditor and are never returned, nor are they ever asked to be returned, he said.

In fact, Mr. Amendola said that in the 25-year history of PACA Trust cases, these are the only two cases he recalls to even broach the subject of preferential payments.

"It's not an issue," he said. "If it was an issue, don't you think it would have come up some other time?"

He said that the PACA Trust law is a tool to help shippers of perishable commodities get paid and is not designed to be a mini bankruptcy proceeding each time there is a past-due debt.

Patricia Rynn of Rynn & Janowsky in Newport Beach, CA, believed that the Schmieding decision got it right while the Fresh Kist judge overstepped the bounds of PACA law. She said it is unreasonable to believe that shippers should basically act as a trustee and determine the financial capabilities of a company just to get a debt paid.

In fact, Ms. Rynn said that the Schmieding decision recognized the inherent problem involved in pitting Trust beneficiary against Trust beneficiary. She said that the judge called it a situation "rife with mischief" if one beneficiary were to basically act as a trustee collecting payments that were then to be distributed to all trust beneficiaries.